Turner and Townsend reported that in the 12 months to the end of June 2019, the construction sector had the highest insolvency rates of any UK sector and we have seen some high profile insolvencies and reported financial difficulties most notably amongst the large tier 1 contractors.
As we move through the transition period the concern in the construction industry is that Brexit could lead to further decreases in demand; and increases in costs of labour and materials from the EU.
Both of which would put even further pressure on contractors’ generally low margins and increase the number of insolvencies in the sector.
With the current heightened risk of contractor insolvency, how can employers seek to limit any potential exposure at the pre-contract stage?
The first step is to ensure that thorough due diligence is carried out on contractors so any insolvency risk can be evaluated pre-appointment and your contract negotiations can be well informed. We have set out below a number of key points to be considered in contract negotiations to seek to limit the effect of contractor insolvency:
- Ensuring that ‘Insolvency’ is widely defined and you have the right to:
- terminate for insolvency as well as other grounds to enable you to terminate before an insolvency event for poor performance or delays;
- make no further payments to the contractor on insolvency until the works are complete;
- complete the works with a replacement contractor and claim additional costs back from the original contractor; and
- enter the site and take control of plant, machinery and materials.
- A performance bond from a reputable UK provider can limit your exposure to its capped amount, although there will be an added cost. You should ensure that it is linked to the contractor’s insolvency (rather than just a breach).
- Parent company guarantees (PCGs) do not generate an additional cost and can provide some level of protection, provided the parent does not also become insolvent.
- Obtaining collateral warranties with step-in rights. These create a direct contractual relationship between you and the sub-contractors/ sub-consultants so that any defect claims can be pursued and, if stepin rights are included, enable you to take over the contract to complete the works.
- Sanctions for the non-provision of PCGs, bonds and warranties to ensure they are provided.
- The payment provisions regarding the level of retention (or a retention bond), frequency of payments, the time between work carried out and payment and advance payment (or advance payment bond).
- A contractual obligation to provide accounts can keep you better informed as to your contractor’s current financial position.
- Using a project bank account will increase administrative burdens and costs money to set up it but it may safeguard funds meant for the contractor’s sub-contractors/ suppliers, which would otherwise be swallowed up in the contractor’s insolvency (provided it creates a trust).
In the next edition of QHU, we will consider the legal and practical issues that arise if a contractor becomes insolvent during a project.